In re Garden Ridge Corp.

• Decision Date: 10 February 2006
• Docket Number: No. 04-10324.,04-10324.
• Citation: 338 B.R. 627
• Parties: In re GARDEN RIDGE CORPORATION, et al., Debtors.
• Court: U.S. Bankruptcy Court — District of Delaware

338 B.R. 627

In re GARDEN RIDGE CORPORATION, et al., Debtors.

No. 04-10324.

United States Bankruptcy Court, D. Delaware.

February 10, 2006.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Joseph M. Barry, Erin Edwards, Sean T. Greecher, Pauline K. Morgan, Young, Conaway, Stargatt & Taylor, Wilmington, DE, for Debtor, Garden Ridge Corporation.

MEMORANDUM OF OPINION AND ORDER

RANDOLPH BAXTER, Bankruptcy Judge.

Before the Court is the motion of Daniel Ferguson ("Ferguson") for relief from the automatic stay under § 362(d) of the United States Bankruptcy Code to the extent necessary to set off certain amounts owing from and owed to the Debtors.¹

The Court acquires core matter jurisdiction over this matter pursuant to 28 U.S.C. §§ 157(a), (b) and 1334(b). Upon an examination of the parties' respective briefs and supporting documentation, and after conducting a hearing on the matter, the following findings of fact and conclusions of law are hereby rendered:

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Garden Ridge Corporation and its jointly administered affiliate co-debtors (the "Debtors") operate home decor retailers with 35 stores in 13 states throughout the South, Midwest, and Mid-Atlantic regions of the United States. Garden Ridge Management, Inc. ("GRM") is a management services company that employs all of the staff and management utilized at the Garden Ridge stores. Garden Ridge, L.P. ("GRLP"), the entity that operates all of the Garden Ridge stores, pays GRM a fee for the use of GRM's employees in its stores. GRM holds a one percent (1%) general partnership interest in GRLP, with the remaining 99% being held by Garden Ridge Investments, Inc.

On January 28, 2001, Ferguson executed an employment agreement (the "Employment Agreement") whereby he was to become a member of Garden Ridge's Executive Committee as the Senior Vice President — Supply Chain.² The Employment Agreement provided that in the event that he was released without cause, Ferguson would receive one year of base salary. The Agreement also provided for the payment of certain relocation costs (including customary real estate commissions up to 6% maximum on the sale of Ferguson's existing house) in conjunction with Ferguson's move to Houston.

On January 31, 2003, due to a delay in the sale of his house in Michigan, Ferguson executed a promissory note in favor of GRLP in the principal amount of $250,000 (the "Note").³ The Note became due and payable upon the earlier of (i) thirty (30) days after the closing of the sale of Ferguson's real property in Michigan, (ii) the date of Ferguson's termination of employment (with or without cause), and (iii) December 31, 2003. Since Ferguson's house remained unsold, the Note was renewed annually. At this time, it is undisputed that the full face amount of the Note remains due.

Ferguson was terminated on September 12, 2003. The parties disagree on whether Ferguson's termination was for cause. Ferguson has initiated a $310,000 cause of action against GRM and GRLP in state court in Texas (the "State Court Action") seeking payment of $250,000 in severance pay (comprising one year of base salary), and $60,000 in unpaid relocation costs.⁴

On February 2, 2004, the Debtors filed for protection under chapter 11 of the Bankruptcy Code. The schedules filed by GRM (the "GRM Schedules")⁵ included an unliquidated claim of Ferguson related to the State Court Action. No accounts receivable from Ferguson were listed on the GRM Schedules. Because GRLP was a named defendant in the State Court Action, the schedules filed by GRLP (the "GRLP Schedules")⁶ also included an unliquidated claim of Ferguson. The GRLP Schedules listed the Note payable from Ferguson.

On April 16, 2004, Ferguson filed an unsecured, non-priority claim in the amount of $310,000 (the "Claim").⁷

The consolidated chapter 11 plan of GRM and GRLP (the "Plan"), along with the other Garden Ridge entities, was confirmed on March 29, 2005.⁸

Ferguson asserts that the amount of $250,000 owed by Ferguson to GRLP on the Note should be setoff by the amount of $310,000 owed by the Debtors to Ferguson for severance fees and various unpaid relocation costs. Ferguson argues that the net result would place him in the position of an unsecured creditor for the $60,000 deficiency outstanding.

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"A creditor who has the right to setoff may obtain relief from the automatic stay in order to implement the setoff." In re Dye, 2004 WL 2249503, *7 (Bankr. M.D.N.C.2004); In re Stienes, 285 B.R. 360, 362 (Bankr.D.N.J.2002) ("In order to exercise a valid right of setoff, a creditor must move for relief from the automatic stay under 11 U.S.C. § 362(d)."). "The right of setoff (also called `offset') allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding the absurdity of making A pay B when B owes A.' Although no federal right of setoff is created by the Bankruptcy Code, 11 U.S.C. § 553(a) provides that, with certain exceptions, whatever right of setoff otherwise exists is preserved in bankruptcy." Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18, 116 S.Ct. 286, 133 L.Ed.2d 258 (1995). Section 553(a) provides, in relevant part, that:

this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case ...

11 U.S.C. § 553(a). "The burden of proof is on the party asserting the right to setoff." E.g., In re Lason, Inc., 314 B.R. 296, 305 (Bankr.D.Del.2004); In re Bennett Funding Group, Inc., 212 B.R. 206, 212 (2nd Cir. BAP 1997). Whether to allow setoff is a determination within the sound discretion of this Court. E.g., In re Continental Airlines, 218 B.R. 324, 328 (D.Del. 1997) (citing United States, Internal Revenue Service v. Norton, 717 F.2d 767, 772 (3d Cir.1983)); In re HAL, Inc., 196 B.R. 159, 161 (9th Cir. BAP 1996) ("Whether or not to allow setoff pursuant to § 553 is left to the sound discretion of the bankruptcy court."); In re Bangert, 226 B.R. 892, 903 (Bankr.D.Mont.1998).

To enforce a setoff right, "[a creditor] must establish that (1) it has a right of setoff under nonbankruptcy law; and (2) this right should be preserved in bankruptcy under § 553." In re HAL, Inc., 196 B.R. at 161; In re Atanasov, 221 B.R. 113, 117 (D.N.J.1998) ("Courts may look to state law in order to determine whether a setoff has occurred, however, the granting or denial of the right to a setoff depends upon the terms of section 553, and not upon the terms of state statutes or laws."); In re Tarbuck, 318 B.R. 78, 81 (Bankr. W.D.Pa.2004) ("The threshold question in every case involving an asserted right of setoff is the source and validity of the underlying right.").

To determine which state's law to apply, the Court turns to Delaware choice of law rules. E.g., In re PHP Healthcare Corp., 128 Fed.Appx. 839, 843 (3d Cir.2005); In re Eagle Enterprises, Inc., 223 B.R. 290, 292 (Bankr.E.D.Pa.1998) (citing Klaxon Co. v. Stentor Electric Manufacturing Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941)) ("In most instances bankruptcy courts rely on the rule observed by federal district courts hearing diversity cases and use the choice of law rules of the forum state."). The Note includes a choice of law provision stating that it is governed by Texas law. Ferguson's action is a breach of contract claim brought in Texas state court, and arising from an employment agreement executed and performed in Texas. Therefore, the Court turns to Texas law to determine whether Ferguson has a right to setoff. See Chemipal Ltd. v. Slim-Fast Nutritional Foods Intern., Inc., 350 F.Supp.2d 582, 595 (D.Del.2004) ("Under Delaware [choice of law rules], express choice of law provisions in contracts are generally given effect."); Matter of Deemer Steel Casting Co., Inc., 117 B.R. 103, 107 (Bankr.D.Del.1990) ("In cases sounding in contract, Delaware's conflicts of law rules require application of the law of the state with the most significant contacts."). Therefore, it is clear, and undisputed by the parties, that Texas laws of setoff applies.

Under Texas law:

Setoff is a form of equitable counterclaim which brings together obligations of parties opposing each other and, by judicial action, makes each obligation extinguish the other. The object of equitable setoff is to adjust the demands between the parties and allow a recovery of only the balance that is due. In order for one demand to be set off against another, both demands must mutually exist between the same parties. Indeed, setoff is proper only where demands are mutual, between the same parties, and in the same capacity or right.

Capital Concepts Properties 85-1 v. Mutual First, Inc., 35 F.3d 170, 175 (5th Cir. 1994) (citations omitted). Similarly, "section 553(a) recognizes and preserves rights of setoff where four conditions exist: (1) The creditor holds a `claim' against the debtor that arose before the commencement of the case; (2) The creditor owes a `debt' to the debtor that also arose before the commencement of the case; (3) The claim and debt are `mutual'; and (4) The claim and debt are each valid and enforceable." See, e.g., 3 Collier on Bankruptcy ¶ 553.01[1]; In re Czyzk, 297 B.R. 406, 409 (Bankr.D.N.J.2003); In re APF Co., 264 B.R. 344, 354 (Bankr.D.Del.2001).

The effect of setoff is to elevate "an unsecured claim to secured status, to the extent that the debtor has a mutual, pre-petition claim against the creditor." Lee v. Schweiker, 739 F.2d 870, 875 (3d Cir.1984); In re Health Management Ltd. Partnership. 332 B.R. 360, 363-64 (Bankr. C.D.Ill.2005).

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The first two elements of setoff are uncontested in this case. Both debts arose pre-petition. The parties have also agreed to separately brief and argue the validity and enforceability of the Ferguson claim at a separate time.⁹ Therefore, the issue to be...